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Retail and Consumer Products: IRS Releases Final Regulations on Treatment of Sales-Based Royalties



The IRS has released final regulations for the treatment of sales-based royalties and vendor allowances which took effect on January 13, 2014.


Sales-based royalties are incurred on the sale of property produced or acquired for resale. Under the prior proposed regulations, sales-based royalties were capitalizable only to property sold or deemed to be sold under the taxpayer’s inventory cost flow assumptions. The final regulations retain this treatment but make the capitalization of the royalties optional instead of mandatory. Any royalties that are entirely allocated to inventory property sold are included in the cost of goods sold.

Sales-based vendor allowances had been treated as a reduction in the cost of the merchandise sold or deemed to be sold under the proposed regulations. The final regulations also treat vendor allowances as reductions in cost but narrow the treatment to “sales-based charge-backs” only. Under the final regulations, sales-based charge-backs are allowances, discounts, or rebates that a taxpayer is entitled to by selling a vendor’s merchandise to specific customers. These customers are identified by that vendor at a price set by the vendor. The final regulations reserve rules for the treatment of other sales-based vendor allowances not discussed.

What Does CohnReznick Think?
These new regulations may ease the compliance burden under Code Sec. 263A. Concerned that the proposed regulations unduly burden taxpayers using the simplified allocation method, the final regulations provide that the allocation of sales based royalties only to property sold is optional rather than mandatory. Regarding sales-based chargebacks, the final regulations allow a reduction of cost of goods sold only, rather than ending inventory, in an effort to more properly match income and expense.


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To learn more about CohnReznick’s Retail and Consumer Products Industry Practice, please visit our webpage.


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